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Growth Options, Beta, and the Cost of Capital
Author(s) -
Bernardo Antonio E.,
Chowdhry Bhagwan,
Goyal Amit
Publication year - 2007
Publication title -
financial management
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.647
H-Index - 68
eISSN - 1755-053X
pISSN - 0046-3892
DOI - 10.1111/j.1755-053x.2007.tb00084.x
Subject(s) - beta (programming language) , cost of capital , economics , cost of equity , equity (law) , implicit cost , capital (architecture) , business , monetary economics , microeconomics , total cost , profit (economics) , archaeology , computer science , political science , law , history , programming language
We show how to decompose a firm's beta into its beta of assets‐in‐place and its beta of growth opportunities. Our empirical results demonstrate that the beta of growth opportunities is greater than the beta of assets‐in‐place for virtually all industries over all periods of time dating back to 1977. The difference has important implications for determining the cost of capital. For example, when choosing comparables to determine a project beta one should match the growth opportunities of the project with those of the comparable firm. Assuming a 6% market equity risk premium, accounting for growth opportunities alters the project cost of capital by as much as 2% to 3%.